Fixed income fix for funds starved corporations

Don Argus
says it is urgent for Australia to make it easier for local companies to sell their debt in this country because of ongoing risks stemming from the European financial crisis.

The former National Australia Bank chief executive and former BHP Billiton chairman said that with more than $250 billion in capital expenditure in the pipeline, the capacity of Australian banks to fund mining and other major projects was limited.

The government could play a role in expanding the domestic corporate bond market by mandating regular reviews of superannuation fund asset allocations and recommitting to the tax incentives for interest income that it has dropped, Argus says.

“For companies, it has become increasingly important to have a diversified range of funding sources and the development of a deep and liquid local corporate bond market would help," Argus tells The Australian Financial Review.

The former banker says the European crisis has heightened the need for local funding sources, which could also benefit investors overly exposed to local shares underpinned by the mining sector.

“The external market is awash with sovereign debt, some of which would have junk status," he says.

“Those junk assets will prevent some banks in the global market from participating in providing liquidity to the debt markets, and given Australia is exposed to external funding markets, the local [funding] option from a risk perspective is looking more attractive as the bad news flow from Europe continues."

Argus is one of many senior business leaders to call for the markets and policymakers to make it easier for local companies to sell their debt in Australia and to shift superannuation funds investment allocation away from equities and into corporate debt.

Over the past decade the Australian corporate loan market has more than doubled in size and Australian corporate offshore bond market issuances have tripled, according to NAB. But Australian corporate bond market activity has remained constant. Local companies issued about $5.6 billion of debt domestically and $27.3 billion internationally in 2011.

Argus says super funds are too exposed to local equities.

“There is some evidence that Australian superannuation is over allocated to equities, particularly Australian stocks that are ultimately very reliant on the fortunes of the mining sector," he says.

“This is an argument for both international diversification of equity portfolios but also increasing the allocation to other investment classes including corporate bonds."

Argus suggests one way to encourage further diversification of super portfolios is to make it mandatory for individuals to review asset allocation of their super portfolios about every three years.

He says the government’s plan to list Commonwealth government securities on the Australian Securities Exchange will help raise the profile of bonds with “mum and dad" investors.

Treasury is also working on reforms to further streamline disclosure requirements that will reduce the compliance costs of companies raising funds from retail investors. It is considering lowering legal liabilities on directors of issuing companies.

Local super funds hold about 50 per cent of their portfolios in shares and 18 per cent in government and corporate bonds, compared with Japan’s 31 per cent and 59 per cent, and the US allocation of 44 per cent and 31 per cent, according to Towers Watson’s global pension asset study.

Chief executive of Credit Suisse in Australia David Livingstone says super funds are “structurally overweight" equities. “That comes from a lack of a fixed-income culture and understanding in Australia," he says.

“You can have a debate and say equities outperform bonds in a 100-year view, but if you’re the person who had 80 per cent of your superannuation in equities before the 2007-08 correction, you lost 40 per cent of your pension if you retired then."

Macquarie Group
deputy managing director
Greg Ward
says the Australian equity culture is largely driven by tax incentives for share investors. “These do give you a better after-tax result for an equity investment ... and that results in different portfolio allocation," he says.

Argus suggests tax rates could be adjusted to create incentives for shifting in funds to fixed-income products. “I suspect that the government will not be enamoured with any initiative that does not produce a tax neutral initiative," he says.

This could also spur the annuities market, he says.

“Annuities provide greatest protection against longevity risk and inflation risk [if they are indexed], with the ability to match cash flows to life expectancy as opposed to the discretionary and uncertain nature of dividends and returns on equity and equity related products," Argus says.